FHFA Gives Banks Reason to Revisit Overlays

The federal government is taking steps to ease a problem lenders have been complaining about for several years, and that’s the buy-back risk they face if they underwrite a federally backed loan that goes bad and the guarantor of the loan—whether FHA, Fannie Mae or Freddie Mac—determines that the loan was never underwritten in compliance with their “representation and warranty” requirements.

Lenders in the wake of the mortgage meltdown cited this buy-back, or repurchase, risk as one of the reasons they were imposing their own set of underwriting requirements above and beyond what the federal guarantor was requiring. With these credit overlays, as they’re called, loan applicants who met the requirements of FHA, Fannie or Freddie could still find themselves getting turned down for a loan, because they didn’t meet these more stringent lender overlays.

NAR in public statements has urged lenders to align their requirements on federally backed loans to what the federal government was requiring. Indeed, NAR Chief Economist Lawrence Yun has estimated that the home sales rate could improve considerably if these overlays were aligned with federal agency requirements.

Yet lenders remain concerned about the risk they face, and in fact earlier this year, in February, Bank of America announced it would stop selling loans to Fannie Mae because of its concerns over the company’s buy-back policies. (Bank of America shortly after the onset of the financial crisis took over Countrywide Home Loans’ book of business, increasing its exposure to buy-back risks from that lender’s loan activity during the housing boom.)

To be sure, banks have made it clear that this buy-back risk is only part of the equation when it comes to their credit overlays. As Chase executive Kevin Watters said a couple of weeks ago in a webinar he participated in with NAR, Chase’s credit overlays are based on its own internal analyses of how well borrowers do under its different loan products. It’s “less about repurchase risk and more about borrower ability to repay,” Watters said during the webinar. “We look at payment history on a specific program, so even though agencies say, ‘Here’s our credit box; it’s okay for you to sell to us,’ if our data indicates that the default rate is high for a borrower with a particular credit profile, we won’t make that loan. Even if the agencies’ credit box is a little wider than ours, we want to make sure we’re comfortable with it.”

Still, action taken yesterday by the Federal Housing Finance Agency (FHFA), the conservator of Fannie and Freddie, could go some way in addressing banks’ concerns over buy-back risk. In a release it issued yesterday, FHFA set out language that clarifies when Fannie and Freddie will, and will not, require lenders to buy back their loans.

Among the clarifications it issued is a 36-month performance standard, in which Fannie and Freddie won’t seek loan repurchases if borrowers make 36 months of consecutive, on-time payments.

For refinance loans that are originated under federal Home Affordable Refinance Program (HARP) guidelines, borrowers only need to make consecutive, on-time payments for 12 months. HARP is the federal program enacted during the mortgage crisis to give incentives to lenders and servicers to refinance loans of underwater borrowers. Borrowers get incentives, too.

The release also says Fannie and Freddie will start their quality control reviews earlier, make more information available to lenders about exclusions to their “rep and warranty” requirements, and provide more tools to keep lenders in compliance.